Senator Marco Rubio (R-FL) introduced legislation to create a new type of federal student loan on May 2, 2019.
The Leveraging Opportunities for Americans Now (LOAN) Act of 2019 replaces interest with a fixed financing fee that is added to the loan balance. The financing fee is non-compounding and does not increase over time.
Financing fees may be easier for borrowers to understand than level amortization of traditional student loans.
The financing fees will be 25% for Federal Direct Stafford Loans and 38% for Federal Direct PLUS Loans.
The legislation does not eliminate origination fees on federal education loans. These fees are currently about 1% for Federal Direct Stafford Loans and about 4% for Federal Direct PLUS Loans.
The monthly payments will be slightly more than 1% and 1.2% of the amount originally disbursed, assuming a 10-year repayment term.
Since the interest rate will be set to zero, the distinction between subsidized and unsubsidized Federal Direct Stafford Loans will be eliminated. No interest will be charged during the in-school and grace periods.
All loan forgiveness and loan cancellation options remain available to borrowers of the new loans.
A new 3-year deferment option will be available to borrowers experiencing extreme economic hardship. Extreme economic hardship is not defined, other than to exclude a change in annual income.
Borrowers are automatically placed in an income-driven repayment plan, the Income-Dependent Education Assistance (IDEA) repayment plan. The IDEA repayment plan bases loan payments on 10 percent of gross income over $10,000. If the borrower’s annual income is less than $10,000, no payments are required. The $10,000 threshold is adjusted annually for inflation.
The borrower’s gross income is calculated annually based on the borrower’s federal income tax returns. If the borrower is not required to file a tax return, the required monthly payment under the income-driven repayment plan will be zero.
A borrower may request that the monthly payment be adjusted to reflect a mid-year change in income.
The repayment obligation under the income-driven repayment plan continues indefinitely, until the loan is repaid in full. There is no forgiveness of the remaining debt after a number of years in repayment, unlike the current income-driven repayment plans, which cancel the remaining debt after 20 or 25 years in repayment. Effectively, this is a form of indentured servitude that may increase the number of retired Americans who still owe federal student loans.
Sen. Rubio’s proposal also implicitly eliminates Public Service Loan Forgiveness (PSLF) for new borrowers, since PSLF will not be available on the new loans.
If a borrower does not file a required federal income tax return, the borrower’s loans will be considered to be delinquent (and eventually in default). The legislation does not address the impact of the automatic six-month extension to file a federal income tax return, nor does the legislation specify the amount of penalties for default.
Borrowers can choose to repay the new loans in equal monthly installments over a 10-year repayment term, but income-driven repayment will be the default option.
The best strategy for most borrowers, especially those whose debt exceeds 80% of their annual income, will involve stretching out the repayment term of the loan as long as possible, since a longer repayment term reduces the effective interest rate.
Annual Loan Statements
The U.S. Department of Education will provide each borrower with an annual loan statement that lists
- Total payments made during each tax year
- Annual payment amount that was due during each tax year
- Current outstanding loan balances
The financing fee on a Federal Direct Consolidation Loan will be equal to the sum of the financing fees on the loans included in the consolidation loan.
It is unclear how the financing fees on traditional federal student loans will be set when they are included in a new consolidation loan. It seems likely that financing fees will be based on the outstanding balance of the old loans at the time of consolidation.
There are no prepayment penalties on the new loans.
To provide borrowers with an incentive for prepayment, the new loans will reduce the financing fee by up to 15 percentage points, depending on the borrower’s income at the time of prepayment. The reductions in the financing fee charged on the amount prepaid are specified in this table.
Borrower’s Income in Excess of $10,000
Reduction in Financing Fee
$45,000 or less
15 percentage points
$45,000 to $95,000
10 percentage points
$95,000 or more
5 percentage points
The $10,000 threshold is adjusted annually for inflation.
Borrowers who plan on paying off their loans within a few years after graduation would be better off under a more traditional student loan.
If enacted, the new loans will become available starting on July 1, 2021.
Borrowers who were enrolled in college on June 30, 2021, will be able to choose whether to receive the new loans or more traditional student loans.
Comparison with Traditional Student Loans
Current loans charge the interest rates and origination fees shown in this table.
Undergraduate Stafford Loan
Graduate Stafford Loan
Assuming that origination fees are added to the loan balance and that interest during the in-school and grace period is capitalized once at repayment with an average duration of 32 months to the in-school and grace periods, the total payments over a 10-year repayment term are as follows:
- Undergraduate Stafford Loan: 146.3% of amount originally disbursed
- Graduate Stafford Loan: 162.6% of amount originally disbursed
- PLUS Loan: 179.6% of amount originally disbursed
The new loans charge the financing and origination fees shown in this table.
Undergraduate Stafford Loan
Graduate Stafford Loan
The total loan payments over a 10-year repayment term are as follows:
- Undergraduate Stafford Loan: 126.3% of amount originally disbursed
- Graduate Stafford Loan: 126.3% of amount originally disbursed
- PLUS Loan: 144.1% of amount originally disbursed
Accordingly, the new loans will reduce total borrower payments by 13.7%, 22.3% and 19.8%, respectively, over a 10-year repayment term.
Sen. Rubio’s proposal is the equivalent of setting interest rates to 4.60% on the Federal Stafford loan for both undergraduate and graduate students and to 6.78% on the Federal PLUS loan, less than the current interest rates.
Sen. Rubio’s proposal will increase costs to the federal government more than $250 billion over a 10-year period. The actual cost may be much greater, depending on the percentage of borrowers who remain in the income-driven repayment plan. Also, the legislation does not consider that the cost to the federal government will increase if the government’s cost of funds increases while the financing fees remain unchanged.
Although there will be some savings from the elimination of Public Service Loan Forgiveness, the savings may not fully compensate for the increase in costs. Sen. Rubio has not stated how he plans on paying for the legislation.
If Sen. Rubio’s goal was to provide a revenue-neutral change, he may have overlooked the interest that normally accrues during the in-school and grace periods.